Tax Reform

It appears that the President’s commission studying fundamental tax reform is nearing its final recommendations. From the NYTimes:

WASHINGTON, Oct. 18 – President Bush’s tax advisory commission agreed today to recommend two alternative tax plans, both of which would limit or eliminate almost all tax deductions, including the ones for state and local income and property taxes.

…The plans are quite sketchy. There is no written summary, much less legislative language. But the basics could be gleaned from a three-hour discussion this morning at the commission’s last public meeting before a final recommendation is written.

For individuals, the two plans are almost identical. These are some of the main elements:

• The alternative minimum tax, a steep levy faced by an increasing number of middle-income taxpayers, would be abolished.
• The tax break on home mortgages would be sharply limited, especially for expensive houses.
• No deduction would be allowed for state and local income and property taxes.
• Employer-paid health insurance premiums above $5,000 a year for an individual and $11,500 for a family policy would be treated as income to workers and taxed accordingly.
• All taxpayers could deduct charitable donations, but only to the extent they exceeded 1 percent of a taxpayer’s income.
• Personal exemptions and deductions and credits for children would be eliminated and replaced by a credit of $1,600 for a single person, $3,200 for a couple, $1,500 for each child and $500 for each other dependent.
• The myriad savings vehicles available now like individual retirement accounts and 401(k) plans would be replaced by three streamlined savings plans and a refundable savings credit for low-income workers.
• The six tax brackets in the existing law would be replaced by four, with a low bracket of 15 percent and a top rate of 33 percent. The top rate now is 35 percent.
• The two plans differ on the way they would treat investment income. One would eliminate taxes on dividends entirely, lower the top capital gains rate to 8.25 percent on the sale of stock in American corporations and tax interest income at the same rate as wages and salaries. The other plan would have a 15 percent rate on dividends, interest and capital gains. The rate now is 15 percent on dividends and capital gains, and interest payments are taxed like earned income.
• One of the biggest changes would be the limits on tax breaks for homeowners. Now, all interest payments on mortgage loans smaller than $1 million are deductible.
• Both plans would lower the limit to the maximum mortgage the Federal Housing Administration will insure. That level changes each year and varies depending on housing costs in each county, with a maximum loan limit now of $312,895 in communities where housing is most expensive and a national average of about $244,000.
• The commission would raise to $600,000 from $500,000 the amount of profits from home sales that would be excluded from capital gains taxes.
• Another big change would be the elimination of the tax deduction on state and local taxes.

In principle, I’m a fan of tax simplification. The tax code has accummulated layer upon layer of complexity with recent tax changes, and I would welcome a real step in the direction of tax simplicity. And the only way to get true tax simplification is to eliminate some deductions, so in that dimension these proposals make sense.

However, the devil is in the details, of course. We’ll have to wait for more specifics about this plan to fully understand the distributional impact that these changes to the tax code would have. The plans are touted as being roughly revenue- and distribution-neutral, but I don’t really believe that; I find it impossible to believe that such dramatic changes in the tax law would leave everyone paying the same tax as before.

Of course, in some sense this is a moot discussion anyway. Given the Bush administration’s disarray, its numerous other priorities, its weakening power to influence the Congress, and Congress’ current penchant for district-level gratification at the expense of the national good, I think that real tax simplification has about as much chance of happening in 2006 as I do being named Greenspan’s successor.

Kash